The markets are pretty rough today, reflecting a strong sell off in China. If you have a 401K account you have a couple of smart options:
- Don’t look. Just keep working.
Option 1 isn’t the most efficient, but it offers value for those who might get emotional over the results (a very natural reaction) and make poor decisions.
Option 2, if you can look at your performance with a degree of distance and can optimize things, rebalancing is for you.
Rebalancing means that you restore order to your portfolio. The stock positions have dropped, the bond positions are likely around the same, perhaps up a little. If you have no cash position available, in order to restore balance you need to sell some of the bonds, and use the proceeds to buy some more of the stocks.
If you haven’t done this recently, your 100K portfolio that was invested 80/20 to stocks and bonds probably looks like this:
- 72K stocks
- 21K bonds
- total 93K
Total allocation 77/23. Your allocation is off, the rebalance brings it back to 80/20 (if you elected an 80/20 mix).
How to quickly calculate how much to sell and buy
- Take the total balance (93K here, but whatever yours actually is) and *20% this is you bond allocation amount: $18.6K
- 21K (current bond allocation) minus 18.6K = $2.4K
- Sell 2.4K, buy the stocks with it.
If you were 60/40 you’d be multiplying total balance by 40% which would 37.2K… and you’d want to make your bonds ‘look like that amount’ by selling down in the same way.
Note that the above is simplified for a 2 position example. IE all bonds, and all stocks. Many accounts may have 4,6,or even 12 positions. The same rules apply. Multiply them all out by the original allocations, and sell the winners to buy the losers.
Why do this?
There are two things going on here: one is that you put yourself back into your original allocation, which if you think about it doesn’t mean much of anything. The second thing that is happening is that you trying to take advantage of the drop by buying more of the depreciated position. The theory is that the price will return, and when it does, you’ll have benefited from the drop, rather than just got back to square 1.
You don’t need to rebalance, and if you are paying monthly amounts into your 401k in its infancy, simply continuing to do so will dollar cost average your way in a similar manner. Note that if you rebalance and the market drops further, you’ll be worse off, so its a long term play, as we hope that after some ups and downs it will ultimately end up higher.
Note that the above is a general idea on rebalancing, and doesn’t constitute a financial advisor relationship. If you want me to personally manage this process, we would need to have a formal written engagement letter in place.